The 10-year Treasury yield has dropped to a key level. If it’s in for a longer slide, a few stocks would benefit the most.
The yield is down to about 4.3% from a high this year of about 4.7% set in late April. Economic growth has slowed, as have many gauges of inflation, making bond returns relatively attractive. That has sent bond prices up, and their yields down.
A downward move in the yield from here could mean it remains lower for a while. It’s treading water at just above 4.2%, where sellers came in several times since the fall of 2023 to send the price lower, and yield higher. If it falls below that level this time, it means buyers are coming in, signaling a major change in sentiment.
Bond investors are eyeing the possibility of lower inflation and economic growth going forward. That makes sense, given that, in the face of slowing growth, the Federal Reserve remains committed to keeping short-term interest rates high, which would further pressure longer-term growth and inflation. So long-dated yields such as the 10-year Treasury could fall further.
“Our long-term gauges support a cyclical down-move in yields,” writes Katie Stockton, founder of Fairlead Strategies.
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That would boost certain stocks, but investors may do well to avoid “cyclical” stocks, which are tied to the perceived health of the economy. Lower growth means less consumer spending, pressuring retailers and restaurants. It could mean less business investment, weighing on profit expectations for manufacturers and materials firms, while pressure on commodity prices would weigh on oil and copper producers. Also, demand for loans would suffer, hurting bank stocks.
But one group of stocks that would benefit from lower yields would be higher-growth names. Companies growing their profits rapidly are valued on the basis that the bulk of their earnings will come years from now—and lower long-dated bond yields make future profits more valuable. That raises these companies’ valuations, or the multiple of near-term expected earnings that investors are willing to pay to own these names.
The technology sector is full of high-growth names. Software companies such as
and
are acquiring new customers, and adding artificial-intelligence enhancements to existing products. Some firms are charging more for that service, and are expected to grow sales and profits faster than the average company in the
Some are chip makers, such as
and
which are expected to sell more chips to data centers to power AI applications. They are also growing faster than the average company.
But a non-tech example is
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It has been successfully pursuing the market for obesity solutions, which many industry-research hubs say could reach over $100 billion several years from now. Analysts expect sales of Lilly’s obesity and diabetes drugs, Mounjaro and Zepbound, to more than double this year to $15 billion combined, and to hit about $60 billion by 2029, according to FactSet. That would drive almost all of the company’s expected 12% annual revenue growth over the next six years. Lilly won’t have to increase spending exorbitantly to reach those milestones, so profit margins should expand and earnings should grow almost 20% a year over that period.
Other stocks that aren’t cyclical and are high dividend payers should benefit from lower yields.
The
Invesco S&P 500 Low Volatility
exchange-traded fund owns tons of such names, including
Walmart
,
and
Investors don’t have to worry about flagging demand for the products these companies make, and their steady cash flows should drive their dividend payments higher. In aggregate, the ETF’s dividend payments for the coming 12 months would yield about 5% to the ETF’s share price, a major reason investors own these names. That yield becomes more attractive when yields on safe government bonds drop, so these stocks could rise.
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Already, both the higher-quality and higher-growth names in the S&P 500 have outperformed the riskier names on the index during the time that yields have dropped, writes Victor Cossel, macro strategist at Seaport Research Partners.
So anyone betting that yields will keep slipping might want to bet on high-quality and high-growth names.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
